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PRODUCTION SHARING CONTRACT

SUBMITTED BY: Anshika Ahuja Megha Gurnani Sharmistha Ghosh Sunanda Bishnoi

INTRODUCTION

Production-Sharing Agreements (PSAs) are among the most common types of contractual arrangements for petroleum exploration and development. Under a PSA the state as the owner of mineral resources engages a foreign oil company (FOC) as a contractor to provide technical and financial services for exploration and development operations. The state is traditionally represented by the government or one of its agencies such as the national oil company (NOC).

The FOC acquires an entitlement to a stipulated share of the oil produced as a reward for the risk taken and services rendered. The state, however, remains the owner of the petroleum produced subject only to the contractor's entitlement to its share of production.

The government or its NOC usually has the option to participate in different aspects of the exploration and development process. In addition, PSAs frequently provide for the establishment of a joint committee where both parties are represented and which monitors the operations.

PSAs are distinguished from other types of contracts in two ways:

First, the FOC carries the entire exploration risk. If no oil is found the company receives no compensation. Second, the government owns both the resource and the installations.

In its most basic form a PSA has 4 main properties.

The foreign partner pays a royalty on gross production to the government. After the royalty is deducted, the FOC is entitled to a prespecified share (e.g. 40 percent) of production for cost recovery.
The remainder of the production, so called profit oil, is then shared between government and FOC at a stipulated share (e.g. 65 percent for the government and 35 percent for the FOC). The contractor then has to pay income tax on its share of profit oil. Over time PSAs have changed substantially and today they take many different forms.

BASIC FEATURES OF PSA

WHY PSC?

PSC regime has a fair balance between financial risks and rewards to the government and the contractor. Several countries at Indias stage of hydrocarbon development have adopted the PSC regime to attract risk capital; mature markets prefer concessionary regime. Countries like China, Indonesia and Brazil pre-salt (deepwater), Mozambique, Nigeria and Angola are key examples. PSC is a robust, transparent and an efficient contract.

PSC A RIGOROUS CONTRACTUAL MODEL

In India, PSC is a Contract between Government of India (GOI) and the Contractor (oil companies) to conduct Petroleum Operations comprising of Exploration, Development and Production of hydrocarbons .
GoI has so far awarded a total of 282 (28 Pre-NELP and 254 NELP) exploration blocks under the PSC regime.

NELP REGIME: PARADIGM SHIFT

Post liberalisation GOI encouraged participation from foreign and private Indian companies in E&D activities. In the pre-NELP 1991-2000 period, GOI invited bids on a regular basis. GoI awarded 47.3% of sedimentary basin area for exploration through NELP, as compared to only 11% in pre-NELP era .

CASE STUDIES

Indonesia was chosen because it is the country first to introduce PSAs. In addition, apart from very few service agreements, all contracts for oil exploration and development in Indonesia are PSAs.

Angola is of interest due to its recent bonanza of large oil discoveries. The FSU is one of the major players in terms of both production and reserves. In order to avoid repetition by analysing all member states we have chosen Azerbaijan as the country that has showed the highest level of activity in the region and, perhaps as a consequence, is best documented with regard to PSAs.

India is widely regarded as one of the more immature 45 oil sectors in a country with potential. Iran has been included as one of the most intriguing openings of a national industry.

As we will see later, Iran's oil contracts combine PSA features with those of traditional service contracts. The chapter is rounded off by a case study of Peru as a representative of Latin America.
Venezuela and Columbia which can be considered the main protagonists in the region are not discussed here since neither of the two countries is in our dataset.

REFORMS BEING INITIATED

GoI constituted Rangarajan Committee to look into the PSCs mechanism and efficacy PSCs fiscal model - cost recovery and sharing of profit petroleum likely to see reforms To overcome difficulties in managing existing models, the committee recommends a new contractual system and fiscal regime based on a royalty payment and production based revenue sharing for future blocks . there are 228 active PSCs

PSC ADMINISTRATION

Disciplined & timely conduct of the MC and its administration is critical. Focus should be to ensure optimisation of JV / work programme performance MC could function like board of a company. The Chairman of the MC should have increased accountability

MC meeting calendar for the forthcoming year could be drawn; much like a board meeting calendar

PSC administration could be in line with the overall stated objective and spirit of the PSC and the NELP policy International best practices emphasize that irrespective of the contracting regime, contract administration and right incentives enable increase production in numerous countries Focus, therefore, could be to improve the efficacy of contract administration

INDIA'S PSC INCENTIVES IN A GLOBAL CONTEXT

In 1998, after four years the Indian government has finally signed off 18 blocks for oil exploration and development under productionsharing agreements. Four of the fields are offshore. The three blocks on the western coast cover an area of 9,865 sq km, the acreage for the eastern offshore field is 7,000 sq km. Onshore the size of the exploration areas ranges from 400 sq km to 7,390 sq km. Total acreage for the. 18 contracts is 53,040 sq km. About 60 percent of the total contract area involves present agreements. In the first phase the PSAs are expected to induce investment totalling $40m which includes $25m of foreign investment.

FINDINGS & SOLUTION

Under a PSA the FOC receives a share of production as a reward for its investment and operating costs and the work performed. It usually bears the entire exploration cost risk and shares the revenue risk with the host country.

The contract is signed before exploration begins and the foreign partner will therefore expect significant rewards later on in the life of the contract. The FOC's revenue is made up of cost oil and profit oil, while the direct sources of revenue for the government can comprise royalties, profit oil, bonuses, taxes, customs duties, and indirect benefits that arise From price caps and DMOs.

PSAs do not divide profits out of market proceeds but instead divide the physical production after allowing a portion of output to be retained by the FOC for the recovery of preproduction and production costs. This means that costs can only be recovered once oil is produced. A source of disagreement at this point can be the definition of costs. This is the basis for the determination of the profit-oil volume that is the part of production remaining after costs in the form of oil have been deducted.
The sharing of production follows a preagreed split between the FOC and the state or its NOC. In theory the state controls the operation but de facto the risk-taking private partner manages the project unless the NOC takes up its option to participate in the venture, which has become more common over time.

PSAs address the important issue of ownership of oil reserves which has made this Contract form politically acceptable in most developing countries. Before the introduction of PSAs the concession agreement vested, for all intents and purposes, the ownership with the foreign company at the wellhead.
Under PSAs reserves and all installations and plants built by the FOC are government property. The PSA is Attractive to foreign firms, particularly those based in the USA, because they can book the reserves in their balance sheets notwithstanding the fact that they do not own them. It seems that the rationale is that the company is entitled to produce for a long period of time, in many cases for as long as the field is alive. During this time it can book the reserves because of access rather than legal title.

despite the wide range, 91 percent of PSAs in the dataset have royalties of either zero, ten, 12.5 or 20 percent. PSAs are the oil industry's equivalent of sharecropping contracts. As with the latter, economic theory suggests that PSAs are inefficient contract forms because the FOC does not receive its marginal product. Thus, the question arises how and why this inefficient form of an oil contract flourishes. Principalagent theory helps to explain how risks and rewards have to be balanced in order to nonetheless let this type of
arrangement prosper. The fact that PSAs are one of the dominant exploration and development agreements points towards their efficiency as an institutional arrangement for risk sharing even if they are inefficient in terms of econheory. In that sense it can be argued that a PSA is a political rather than an economic contract.